PRODI'S TRUTH
The Times leader 99-06-23

The euro is too fragile to permit of honest economic debate

Romano Prodi's attitude to economic and monetary union is that of a missionary at prayer. Before being appointed as the next President of the European Commission, his main claim to European fame was as the Italian Prime Minister who, to general astonishment, squeezed Italy into EMU in the first wave. At home, he has championed economic reform; and his intention, when he addressed a congress of Italian industrialists this week, was undoubtedly to underline the need for "radical choices".

But in the process, he let slip the thought that if unless Italy halved its quite modest inflation rate, its costs would exceed those of rivals in the eurozone to the point where "we will not be able to stay in the euro". The euro promptly fell against the dollar. Signor Prodi, his back to the wall, first made matters worse by saying that he was merely quoting the Italian board member of the European Central Bank, then fell back on the standard defence of politicians in trouble, saying that he had been misunderstood. That has not spared him torrents of criticism, not because what he said was not true, but for opening his mouth on this most sensitive subject at all.

Some of this criticism is justified. Signor Prodi has become the first prominent EU politician to hint, heresy of heresies, that economic divergence could, if not corrected, force a country out of EMU. What makes this dynamite is that the eurozone economies are in fact diverging. EMU is certainly not about to fall apart. But for the next President of the Commission, of all people, to voice the merest hint that EMU might not be irreversible is bound to make the currency, which has had a less than easy birth, more unstable.

Any element of doubt is subversive of the entire EMU project; it is EMU's irreversibility that distinguishes it from the ill-starred European exchange rate mechanism; were speculators to begin to doubt EMU's staying power, they could be tempted to test it. If its members do not have unconditional faith in it, it will be much harder to make EMU work - and make it less attractive for others, notably Britain, to join. The euro has, after all, been in existence for less than six months and has yet to be tested by any unexpected crises. If it is possible to imagine a country changing its mind if things went wrong, that is no advertisement for its ability to withstand the shocks of a serious recession.

But it is a huge step to go on from there to argue, as some of Signor Prodi's critics have done, that EU politicians are therefor duty-bound to co-ordinate all comment on EMU. There is a difference between weighing their words carefully and thought control by the European Central Bank. If people suspected that their elected leaders, bound by a vow of silence, would never admit it even if the eurozone was under serious strain, that would damage economic confidence and the euro with it.

Germany's economic problems will continue to drag down the prospects for growth and employment in the eurozone for some time yet. Europe needs more, not less, discussion of its structural problems; but in euroland, this is bound to remind voters that they are laced into the double straitjacket of the single interest rate and stability pact. It does not help Tony Blair, as he attempts to damp down the euro debate with the warm waters of domestic policy, that the furore over Signor Prodi's home truths has underlined the euro's dominance over European political debate.

FT Lex on Prodi 99-06-22
Romano Prodi, former prime minister of Italy and European Commission president in waiting, claims he was misinterpreted. But for a man in his position even to mention the possibility of Italy's failing to remain within the euro-zone was downright naive.

The euro was just starting to recover some ground on the back of a pick-up in the German economy. Prodi's remarks sent it back down to $1.03, within sight of its low against the US dollar. And the hubbub did nothing to improve investor sentiment towards Italian assets already shaken by the slippage on this year's budget deficit: government bonds fell almost a point.

The real problem is that Europe's ruling class, political and financial, has not yet adjusted to the realities of single currency life. Never mind whether the authorities are singing from the same hymn sheet; some do not appear to be adherents to the same religion.

Far too many people are expressing discordant views on interest rates, the need for a demand boost and the prospects for micro-economic reform; while on the euro itself, the rhetoric flickers between benign neglect and toothless attempts to talk up the currency.

In the medium term, a combination of a rebound in Europe's economy and the sheer scale of the US trade deficit should start to push up the euro against the dollar. But until Europe's elite realise that careless talk weakens the euro's credibility, the new currency's progress will be volatile.

BBC, June 22, 1999

Prodi tries to calm euro

The new president of the European Commission, Romano Prodi, has insisted there is no danger of Italy having to leave the European Single Currency.

Mr Prodi was attempting to clarify an earlier warning that Italy's membership of the single currency could be at risk if economic reforms falter. The latest crisis for the fledgling currency was sparked by Mr Prodi's speech in his home town of Bologna, in which he told business people that costs in Italy were still too high.

"If we continue to have costs which diverge from other European countries it will be

more difficult to remain in the euro," he said. Mr Prodi warned his fellow countrymen that Italy had to make "radical choices".

"The euro is a big opportunity but without radical choices, it could become a sanction," he added. Mr Prodi's remarks carry a particularly strong impact because he is widely regarded as the architect of Italy's bid to join the single currency. Under his leadership, Italy qualified for membership by sharply reducing its budget deficit.

Mr Prodi's comments led to a sharp drop in the value of the euro on foreign currency markets. Weak growth in Italy and Germany are partly to blame for the euro's turbulent history. It has fallen by more than 12% since its launch in January.

Mr Prodi said later that his remarks had been reported "in a very ambiguous and wrong way". He said: "Italy is not in any danger of having to leave the euro in the short-or medium-term."

He added that his statements had been "misunderstood" and that they were reported by several media in an "ambiguous and mistaken" way. He insisted there was no immediate threat to Italy's position as there was only "a teeny tiny difference" of just 1% between its inflation rate and the other 10 euro-zone nations.

However, he acknowledged that in the long term, Italy would have to eliminate the difference completely. "It's a question of interpretation, and we feel Mr Prodi was trying to direct his comments at Italian industry to get its act together rather than putting Italy's euro membership on the line," said Mike Wallace of MMS International.

Meanwhile the head of the German central bank was trying to talk up the value of the euro. Hans Tietmeyer, the current head of the Bundesbank, said that the euro had enormous potential if it was politically convincing.

Wall Street Journal 99-06-22

Prodi Voices Concerns About Euro, Undoing Recent Gains Against Yen

TOKYO -- Continued intervention by the Bank of Japan wasn't enough to prevent a few misplaced words by Romano Prodi.

The gains of the euro against the yen in recent days, driven by the European Central Bank's intervention on Friday on behalf of the Japanese central bank, were undone on Monday by concerns expressed by Mr. Prodi, the president-designate of the European Commission, about Italy's ability to remain within the unified currency regime.

"Losing one percentage point of competitiveness a year, if it goes on in time for a number of years, would become a condemnation for Italy and it would be difficult for us to stay in the single currency," Mr. Prodi told a group of chemical-sector executives in Milan.

His comment, which he hastily amended in interviews later Monday, drove the euro off its recent highs.

Market Uncertainty

The euro's renewed slippage, despite the Bank of Japan's actions, underscores the continued uncertainty in the market toward the unified currency, analysts said. "It just shows that people aren't comfortable holding euros at the moment," said Michael Metcalfe, a currency strategist at Natwest Securities Ltd. in London. "People are unconvinced that the euro's strength is here to stay, which given its short history is understandable."

Learning that his remarks unsettled the markets, Mr. Prodi said later Monday that his comments had been taken out of context. There is "no chance in any case of leaving" European economic and monetary union, he said in a television interview.

As Mark Twain said: “Language is a treacherous thing, a most unsure vehicle.”

It is a sentiment with which Romano Prodi, the European Commission's president-designate, might heartily concur.

Experienced politician though he is, Mr Prodi this week earned the unfortunate distinction of becoming the first prominent European leader to raise the possibility that Europe's six-month-old monetary union might not last forever.

In so doing, he highlighted the consistent inability of European policymakers this year to speak with one voice and stand united behind the single currency.

Addressing an audience of fellow Italians on Monday, Mr Prodi said Italy could find it hard to stay in the euro-zone - the 11 countries that adopted the single currency at the beginning of the year - if it failed to match its partners in economic competitiveness.

It was a rhetorical flourish of sorts, aimed largely at reminding Italian industrialists to keep their costs down. It was not remotely intended to suggest that Italy risked dropping out of monetary union. Moreover, Mr Prodi quickly asserted that his speech had been reported “in a very ambiguous and wrong way”.

From the viewpoint of financial markets, however, Mr Prodi had let the cat out of the bag. Within minutes of his remarks, the euro went down and the risk premium for holders of euro-zone financial assets went up. Many managers of fixed-income funds reduced their holdings of euro-zone issues.

At the very least, it seemed imprudent for Mr Prodi to air even the theoretical possibility of a break-up of monetary union so soon after the euro's launch. According to the treaties that established the single currency, monetary union became irrevocable when the 11 founder members fixed their exchange rates against each other in January.

Yet it is no secret that Germany, the EU's largest country, was once doubtful of Italy's ability to sustain euro-zone membership. Italy is one of Europe's slowest-growing economies, and the European Central Bank voiced public concern last month when EU finance ministers gave Italy permission to relax its budget deficit targets for this year.

This appeared to be a first crack in the EU's Stability and Growth Pact, an agreement designed to guarantee. fiscal discipline in the eurozone. And in spite of the ECB's worries, Massimo D'Alema, Italy's prime minister, suggested last Sunday that other countries might try to win similar concessions.

For some EU politicians, this week's debacle raises a different concern; that Mr Prodi may still be distracted by Italian politics and by his increasingly bitter personal feud with Mr DAlema.

Mr Prodi, who was prime minister for 28 months until last October, did much to ensure Italy's entry into monetary union and has given considerable attention to his role in Brussels. He intends to announce a new Commission next month and has made progress in outlining a fresh structure for commissioners' portfolios.

But the dramatic tone of his comments on Monday, when he warned of the “tragedy” awaiting Italy if it failed to become more competitive, is the latest indication that he believes the D'Alema government has been too slow in pushing through economic reforms.

Although the two men led the centre-left Olive Tree coalition to victory in Italy's 1996 general election, they are today barely on speaking terms. “Not a day goes by, not even an hour, in which the two don't find some way to attack each other, coming close to personal insults,” the centre-left newspaper La Repubblica commented yesterday.

Mr D'Alema believes Mr Prodi split Italy's centre-left by campaigning for his new party, the Democrats, during the recent European parliament elections.

Mr Prodi believes the centre-left will lose Italy's next election, due by April 2001, unless Mr D'Alema moves his coalition towards the more centrist policies espoused by his own party. Some Italian politicians think Mr Prodi cannot shake off his conviction that Mr D'Alema conspired to bring down his government last year. “Prodi's period of grief is not yet over,” said one government member.

Many will see Mr Prodi's remarks as another example of how national politicians sometimes find it hard to adjust to the demands of the pan-European stage.

“Prodi does not take over full-time until September, and this period would be frustrating for anybody,” said an adviser to the Italian government.

But the likelihood is that the next Commission president will also be a pivotal figure on the Italian political scene for the foreseeable future.

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